Nearly one in five American households qualify as accredited investors, the SEC says in a new staff report that reads like a curtain-raiser to pending private fund reforms.
In 1983, about 1.5 million homes – less than 2 percent of the nation’s households – met one of the three income or net worth thresholds to qualify for accreditation under Regulation D, regulators say in the new report. At the end of 2022, more than 24 million American households – 18.5 percent – qualified as accredited investors, the commission’s analysis finds.
Under Regulation D, private equity and other fund managers can avoid volumes of disclosures and untold thousands of compliance hours and dollars so long as they sell either exclusively or mostly to accredited investors. Critics, including consumer advocates, state regulators and especially Democratic commissioner Caroline Crenshaw (registration required), have long argued that the accredited definitions need an upgrade because wealth is a poor proxy for sophistication and the sheer number of accredited investors pose a systemic risk to the economy.
When he took office in 2021, SEC chairman Gary Gensler made Reg D reforms – including new accreditation standards – his top priority. Nothing has come of it yet, but he’s promised (registration required) to bring new rule proposals in the Spring. Core elements of Friday’s staff report are likely to make their way into any new rule proposals.
Inflation and individual retirement
In Friday’s report, regulators attribute the explosive growth in accredited investors to two factors. The first and most important one is that the wealth thresholds, set in 1982, have never been adjusted for inflation. Had those thresholds kept up with inflation, less than 6 percent of American households would qualify as accredited investors, regulators claim.
The second factor is the collapse of defined benefit retirement plans in favor of defined contribution plans or IRAs, regulators claim, because the individual accounts are factored into a household’s net worth. In 1980, less than 3 percent of American retirement plans were invested in IRAs. By 2022, more than a third of all retirement plans were invested in IRAs. Under existing rules, including retirement plans in a household’s net worth mean that 12.5 percent of American households qualify as accredited investors. If retirement plans were excluded from the net worth calculations, less than 9 percent of households would be accredited, regulators claim in Friday’s report.
“This movement away from defined benefit plans may have created investor protection considerations not present to the same degree at the time of the adoption of the income and net worth thresholds,” regulators claim in the 53-page report. “Specifically, much of the responsibility for the management of retirement investments shifted from employers and professional pension fund managers to individual participants. Those individuals may have little, if any, prior investing experience and may not seek the assistance of professional advisers. In defined benefit plans, employers are responsible for appropriately managing risk, including selection of investments and monitoring to ensure proper risk allocation based on market developments and participant activities, to ensure the defined benefit plans remain properly funded.”